Reaction Wheel

Thank you to Tom Eisenmann of HBS, who gave valuable feedback on a couple of iterations of this.

I teach entrepreneurship at Columbia University. We devote the second-to-last class to a Harvard Business School case study about the early years of Zipcar. It’s a good case and we can review most of what we learned through the lens of the problems Robin Chase faced just before raising her second round of financing.

In the last class we talk about fundraising and venture capital. For continuity, I decided to use Zipcar as an example of the mechanics and norms of VC funding: pre- and post-money, preferred stock, rounds, dilution, etc. Since Zipcar had been a public company, I figured public documents would contain most of the numbers I would need to piece together the story.

This is that story, as far as I could really piece it together. It was stranger than I had assumed it would be, and that was good. My general philosophy about taking VC money is as Rilke’s to writing: if you don’t feel you absolutely must, then don’t. The story of Zipcar’s financing illustrates one of the many ways a company can be successful while its founders are not. It also shows some major mistakes by early investors.

This post isn’t a primer on venture capital, it’s a real-world example of how things can play out. I know that I’m throwing you in the deep end, but Fred Wilson and Brad Feld have explained the mechanics well: if you don’t recognize a term, visit one of their blogs and search for it.

Most of the information in this analysis is drawn from the 424(b)(4) form that Zipcar filed with the SEC in April 2011, soon after their IPO. The 424 is called a Prospectus. The SEC requires a form 424 after an IPO and it contains much of the business and financial information about a company that a public market investor needs to make a rational investment decision. Most of the information in the 424 the company only needs to provide for the three years prior to the filing, so many details about the early years of the company I had to infer from agreements and ownership that survived until the years covered in the filing. I made some guesses to fill in the gaps. I will describe these below.

One thing to note in this analysis is that I refer to the number of shares on an as-converted basis. This is important because the company did a 1:2 reverse split before the IPO–probably to make sure the trading price at IPO would be above $10/share. Because of this, all of the preferred share amounts in the 424 need to be halved to know how many shares the holder will own after the IPO. That is, if a shareholder owned 1,000 Series B shares, those preferred shares will convert into 500 Common shares at the IPO. It is easier to compare the value of different types of shares over time using their common equivalents, so that is what I did. The base data and calculations I made are in this Google Sheet, with references back to the Prospectus. You don’t need to refer back to the 424 to follow this, but I included the references so if you want to have a go at reading the SEC document and tying it back to the actual business, you can. The ability to parse SEC documents has been extremely useful in my finance career so if finance is the road you’re going down, reading through and understanding SEC documents is a good thing to be able to do. Just sayin’.

The second one thing to note is that some of the breadcrumbs around ownership in the early years come from interviews in the media with Chase or others. Chase, in particular, seems to be an unreliable narrator. For instance, in one interview she says “When I finished raising a $7 million round of financing in 2003”¹, but the financials show that only $4,000,000 was raised in the round that closed that year. That round was announced as a $2 million round by Crunchbase². The information on Crunchbase seems to reflect the first close in a larger round and Chase may be confused about timing, with $4.7 million closed in December of 2002, $4 million closed in November of 2003, and a $2 million bridge note somewhere in that time-frame as well. The point is: what people say to the media may not be accurate, for whatever reason. I relied on SEC documents for the facts, and considered other information interesting but not definitive.

Founding

The company was formed in 2000 by Antje Danielson and Robin Chase. They split the equity 50/50. This analysis assumes they each received 570,000 shares of the new company.

This number, how many shares the founders started with, is one of the most speculative assumptions in the analysis. There is no way of really knowing from public information. In fact, I am pretty sure it isn’t exactly right: who starts a company and decides each founder gets 1,140,000 shares (pre-reverse split)? Why not exactly 1,000,000 each or 2,500,000 to split? That said, it’s my best guess. I arrived at it from three directions:

1. The number of Common shares at IPO that weren’t otherwise accounted for was 1,081,610, and some of these seem to have been issued when the pre-Series A convertible note converted (the second most speculative assumption here);
2. An article about the company, with an interview of Danielson, said “Danielson remained a Zipcar shareholder until Avis bought the company in early 2013. ‘I started off with 50 percent of the company,’ she says. But after multiple rounds of funding, she ended up with 1.3 percent.”³ To make the number work, I have to assume this is 1.3% of the company before the IPO and not counting dilution from unexercised options and warrants;
3. A different article about the company said “People close to the company said that shortly after Zipcar was launched, Chase controlled more than half of the shares. An early round of capital raising brought her share down to around 20 percent. But the real share-killer was a round of financing the company did in 2002, when the capital markets were reeling after the dot-com bust and 9/11. That investment round brought her shares down to around under 10 percent. By the time the company went public in 2001, Chase owned around 3 percent of the company…”⁴ Chase could not have owned 3% of the company just before the IPO: there just weren’t enough Common shares outstanding. Perhaps she owned a huge chunk of the options, but that seems unlikely–both because of what happened and because she would have had to exercise them when she left the company, and there weren’t that many exercised options. But it seems likely that Chase did own more than Danielson; I am told by someone who has spoken to Chase that Danielson voluntarily walked away from some shares when she left the company. Maybe this is true.

There is also the possibility that Chase or Danielson or both sold shares back to the company at some point (probably not in a secondary because then they would still be outstanding Common shares). If this happened it was probably after the Series C because the company wouldn’t have wanted to part with the cash before then. There is no way to know from the information I have.

Assuming this, at founding the capitalization table–the enumeration of who owns what shares–would have looked like this (shares and dollars in the cap tables are in thousands):

Owner	Date	Common Stock	Preferred Stock	Total Stock	%	Investment
Chase	1/2000	570		570	50.0%
Danielson	1/2000	570		570	50.0%
.
Total		1,140	0	1,140		$0

Series A

The Zipcar case says “[Chase and Danielson] had incorporated in January 2000 and raised their first $50,000 from one angel investor…By October, the fledgling company had 19 vehicles, nearly 250 members, and the founders had raised—and spent—an additional $325,000 to fund the early stages of operations…Beginning in early 2000, Chase had made a series of presentations to potential investors in which she sought $1 million in capital.”⁵

The Prospectus tells us how many shares of each series of preferred stock are outstanding as of the IPO and what their preference is. Since venture capital preferred stock always has a purchase price equal to the preference, from this we can tell for each series how much was invested and how many shares were bought. And indeed, it shows that in October 2000 the company raised $1,035,606 by selling shares of Series A stock with a preference of $3.80 per share (again, on an as-converted basis): 272,528 shares.

In an interview years later, Chase said “The decision to expand to other cities came after we closed $1.3 million in Series A financing.”⁶ Similarly, the MIT version of the Zipcar case study says “With just three weeks until the company closed on its first round of funding worth $1.3 million…”⁷ I’m going to assume that the difference between the $1.3 million reported as raised and the $1.0 million actually raised is the amount of convertible notes raised before the Series A. If we assume the HBS case misspoke when it said $50,000 plus an additional $325,000 and meant simply $325,000 total, then the $1.3 million makes sense. (If it were indeed $375,000 on top of the $1,035,606 then they would have almost certainly rounded to $1.4 million. In general, everyone involves likes reporting larger numbers).

But then this means the Convertible Notes converted into Common stock, not Series A Preferred. That isn’t unusual, although it’s a really bad idea if you’re the investor, as you’ll see in a minute. I assume the Notes converted at 85% of the Series A price (in my experience, 15% was a more usual discount in 2000, while 20% is more usual now). This resulted in an additional 100,619 Common shares.

I also put in an option pool equal to 20% of the post-round company. This is fairly usual, although the size of the pool can vary. But I was also trying to get the founders closer to the “around 20 percent” mentioned in the quote above. This doesn’t get them there, but I can’t square the 20% after the first round with the 10% after the second round anyway. I think the quote given to CNBC is probably inaccurate.

Cap Table After the Series A

Owner	Date	Common Stock	Preferred Stock	Total Stock	%	Investment	Value
Chase	1/2000	570		570	30.1%		$2,182
Danielson	1/2000	570		570	30.1%		$2,182
Convertible notes	?/2000	101		101	5.3%	$325	$382
Series A investors	10/2000		273	273	14.4%	$1,036	$1,036
.
Options + pool		378		378	20.0%
.
Total		1,619	273	1,892		$1,361	$5,750

Some points I made to my class here:

• Chase and Danielson own a smaller percentage of the company after this round than before the round even though they own the same number of shares. That’s because the shares the investors bought were new shares issued by the company: the denominator changed, not the numerator. This is called dilution.
• The post-money is the total number of shares, including the option pool as if issued and exercised, times the round price: $7.2 million. The pre-money is the post-money less the amount invested in the round. In this case that is $6.2 million if we don’t count the convertible notes, or $5.8 million if we do.

Series B

In December 2002 the company raised another round of financing, the Series B.

Just before that, Chase fired Danielson. You may think this is strange, since they were equal partners, but the company had formed a board of directors after the first venture round and the board gave Chase the ability to fire anyone at her discretion. Remember that when you take money from VCs you are giving them some say over how your company is run. When things are going well, this doesn’t matter. When things are going badly, it does. And in the run-up to the Series B things were going badly.

The dot-com bubble popped in March 2000, but many were convinced that the market would come back, that it was just a temporary setback like in 1997. So Zipcar’s Series A in October 2000 was fully priced. But the market didn’t come back and 2002/2003 was the worst time to raise venture money in the last quarter-century. By then most investors wouldn’t touch startups with a ten-foot pole. The Series B price reflected that.

The company raised $4.7 million at a price of $1/share.

One dollar per share is much lower than the Series A price of $3.80/share. This was a down round. The holders of Common stock found their shares worth less (on paper) than they had been previously. This includes the holders of the Common shares issued on conversion of the Convertible Notes. The holders of the Series A seem to have had a contractual mitigator though: an anti-dilution clause⁸.

Anti-dilution works this way: if you buy shares for a certain price (and your purchase contract grants you anti-dilution: this only exists if you specifically negotiate it when buying the shares) and then, later, the company sells shares for a lower price, your price is effectively lowered as well. How much it is lowered depends on the type of anti-dilution right. If you have full-ratchet anti-dilution, then your price is effectively lowered to the latest, lower price. More common is weighted-average anti-dilution where your price is lowered to somewhere between your price and the new, lower price.

In this case, where there were a lot of new shares issued at $1/share versus the few shares that were issued at $3.80/share, and the effective price of the Series A was reduced to $1.49, it looks like it was weighted-average anti-dilution^9,10.

Owner	Date	Common Stock	Preferred Stock	Total Stock	%	Investment	Value	Value @ Last Round
Chase	1/2000	570		570	8.3%		$570	$2,166
Danielson	1/2000	411		411	6.0%		$411	$2,166
Convertible notes	?/2000	101		101	1.5%	$325	$101	$382
Series A investors	10/2000		695	695	10.1%	$1,036	$695	$1,036
Series B investors	12/2002		4,704	4,704	68.6%	$4,704	$4,704
.
Options + pool		378		378	5.5%
.
Total		1,460	5,400	6,860		$6,065	$6,481

The pre-money here is $2.2 million and the post-money is $6.9 million. You can see that the founders got slammed: Chase’s ownership went from ~30% to less than 9% and the notional value of her shares went down 74%. The value of the Common shares issued for the Convertible Notes was also down 74%. But note that the value of the Series A shares was only down 33% because of the anti-dilution.

The people who invested in the Convertible Notes probably thought they were getting whatever the Series A investors would get, but at a cheaper price. But if it’s true that they ended up with common shares instead of preferred then they were wrong, very wrong. If they had gotten the Series A anti-dilution they would have owned more than 2.5x what they did.

I was told that when she was fired Danielson “walked away” from some of her shares, meaning she either gave them back to the company or the company bought them from her. This lead to her having fewer shares than Chase, as discussed above.

Series C

In 2003 Robin Chase was fired and the company hired a new CEO, Scott Griffith. While most startups don’t so closely resemble a season of Game of Thrones, it’s not surprising this happened immediately after the Series B investors took a controlling stake in the company. Griffith was granted 700,000 shares of restricted stock. Restricted stock usually has some conditions attached, such as vesting.

In November 2003 the company raised $4 million at $1.40/share. I had not increased the option pool before the Series B raise, but here I increase it so that it is again 20% of the company’s shares. It is not unusual for the option pool to be increased at each raise, although the pool as a percentage of the whole company usually shrinks as the company gets larger. In this case, the pool plus exercised options at IPO was 18.6%, I kept the pool at 20% until the Series F.

Owner	Date	Common Stock	Preferred Stock	Total Stock	%	Investment	Value
Chase	1/2000	570		570	4.5%		$798
Danielson	1/2000	411		411	3.3%		$575
Convertible notes	?/2000	101		101	0.8%	$325	$141
Series A investors	10/2000		695	695	5.5%	$1,036	$973
Series B investors	12/2002		4,704	4,704	37.5%	$4,704	$6,586
Griffith restricted stock	2/2003	700		700	5.6%		$980
Series C investors	11/2003		2,857	2,857	22.8%	$4,000	$4,000
.
Options + pool		2,510		2,510	20.0%
.
Total		4,292	8,257	12,549		$10,065	$14,054

The pre-money is $13.6 million, and the post-money is $17.6 million.

Series D

The Series D was led by Benchmark in January 2005. The company raised $11.7 million at $2.32/share. The pre-money was $32 million and the post-money was $44 million.

If you want to see how much a company grew in value between rounds, the right way to do it is by share price. Going from $1.40 to $2.32 is 66% growth. If you compare the post-money in the last round to the pre-money in this round, you go from $17.6 million to $32 million: 82% growth. The difference here is in the options being added to the option pool.

You may ask why unissued options are included in valuations at all (by including them, the price per share is lower at any given company valuation). Or why they are usually added to the pool before the round rather than after (if they were added after the round, the additional pool would dilute both the previous holders and the new investors; adding them to the pool before the round dilutes only the previous holders). This is the wrong thing to worry about. Focus instead on price per share. You, as a founder or previous investor, own a certain number of shares. This doesn’t usually change, unlike your percentage ownership. The number of shares you own and the price per share now and in the future are what should matter to you.

I’m not going to insert the cap table for each of these rounds. If you want to see it, visit the Google Sheet: there is a tab for each round.

Series E

The Series E was also led by Benchmark, with Greylock investing. The company raised $25 million at $7.32/share in November 2006. The pre-money was $152 million and the post-money was $177 million. The price per share grew by 216% in less than two years. Nice round.

Series F and Streetcar Acquisition

The Series F was different. These shares were issued to acquire Flexcar, one of Zipcar’s competitors, in November 2007. They amounted to 30% of the as-converted equity of the combined company.

There were also Warrants issued as part of the purchase price for Flexcar. Warrants in a startup function exactly like options: they allow the holder to purchase shares in the future at a set price. If these are issued to employees they are called options. If they are issued in acquisitions or to partners they are called warrants. Warrants are often issued to banks when they agree to lend money, and sometimes to landlords when they lease property, etc. I don’t include these warrants explicitly in the cap table below, because they come out of the option pool so they are in that line.

In April 2010 Zipcar also acquired a European competitor, Streetcar. They issued 4.1 million shares of Common for this acquisition. Why was the Flexcar acquisition paid for in preferred stock while the Streetcar acquisition was paid for in Common stock? Usually when an acquisition is made with preferred it is because the target is also venture backed and the venture investors want their preference in the target company replaced by preference in the acquiror. The acquiror would usually rather not have more preference because preference amounts make a difference when the company is sold for less than what the preferred stock holders would get if they converted; in some of those cases there is not enough money to pay back all the preferred and the sale price is then divvied up based on how much preference there is.

A simple example: Company A has one investor, Ms. V, who bought 20% of the company for $1,000,000 at $1/share. She received preferred stock.

• If the company is sold for more than $5,000,000 then Ms. V would convert her preferred to 20% of the company and get 20% of the sale price, ie. > $1,000,000;
• If the company sells for between $1,000,000 and $5,000,000, Ms. V does not convert and instead takes her $1,000,000 in preference;
• If the company sells for less then $1,000,000 then Ms. V takes the whole amount, whatever it is¹¹.

Now imagine that Company A buys Company B and issues 1,000,000 Common shares to pay for it. This dilutes Ms. V from 20% to 16.67% ownership. So now

• If the company is sold for more than $6,000,000 then Ms. V would convert her preferred to 16.67% of the company and get 16.67% of the sale price, ie. > $1,000,000;
• If the company sells for between $1,000,000 and $6,000,000, Ms. V does not convert and instead takes her $1,000,000 in preference;
• If the company sells for less then $1,000,000 then Ms. V takes the whole amount, whatever it is.

If instead Company A had issued preferred shares with a $1/share liquidation preference to acquire Company B, then Ms. V is in a different position. In this case,

• If the company is sold for more than $6,000,000 then Ms. V would convert her preferred to 16.67% of the company and get 16.67% of the sale price, ie. > $1,000,000;
• If the company sells for between $2,000,000 and $6,000,000, Ms. V does not convert and instead takes her $1,000,000 in preference;
• If the company sells for less then $2,000,000 then Ms. V shares the amount pro-rata with the other preferred holder, in this case 50/50.

In buying Company B, Company A has raised the threshold for Ms. V to get a positive return on her investment, as well as the threshold for getting her money back in full. This all makes sense. But by using preferred to buy Company B, it has halved her cut of any amounts below $2,000,000.

I’m sure you’re not crying for Ms. V, but think about it from the point of view of Company A’s Common shareholders: they only make money after the preferred is paid back. By doubling the amount of preference the company has doubled the sale price at which the Common take home any money at all. This is called the liquidation preference overhang or just liquidation overhang. It may seem like not a big deal in this example but imagine this scenario with the dollar amounts multiplied by a hundred.

Issue common when you can.

Series G

The Series G was led by Meritech in December 2010. The company raised $21 million at $15.22/share. The pre-money was $539 million and the post-money was $560 million. The share price grew 108% in the four years since the Series E. Much slower growth, but not so bad.

I did not increase the option pool for the Series F because it was not a real round. And I used the actual number of options (and warrants and restricted stock) from the Prospectus here.

Owner	Date	Common Stock	Preferred Stock	Total Stock	%	Investment	Value
Chase	1/2000	570		570	1.5%		$8,675
Danielson	1/2000	411		411	1.0%		$6,255
Convertible notes	?/2000	101		101	0.3%	$325	$1,531
Series A investors	10/2000		695	695	1.8%	$1,036	$10,581
Series B investors	12/2002		4,704	4,704	11.9%	$4,704	$71,601
Griffith restricted stock	2/2003	700		700	1.8%		$10,654
Series C investors	11/2003		2,857	2,857	7.3%	$4,000	$43,491
Series D investors	1/2005		5,059	5,059	12.8%	$11,736	$76,991
Series E investors	11/2006		3,249	3,249	8.2%	$25,015	$49,445
Series F (Flexcar)	11/2007		7,154	7,154	18.2%		$108,881
Streetcar acquisition	4/2010	4,093		4,093	10.4%
Series G investors	12/2010		1,380	1,380	3.5%	$21,000	$21,000
.
Options + pool		8,445	8,445		21.4%
.
Total		11,686	25,098	36,784		$67,816	$409,106

IPO

Just five months after the Series G Zipcar went public. On April 19, 2011 public market investors bought  9,684,109 shares of common stock. 6,666,667 of these shares were sold by Zipcar directly, for $18/share, less the7% underwriting banks took as their fee. Zipcar ended up with $111 million of proceeds, and the banks took home $12 million for their trouble. Why do investment banks make this much for being an intermediary? No good reason. But very few companies are able to negotiate a lower price, though you can if you’re big enough; SNAP seems to have paid 2.5%¹². Even fewer are willing to buck the process entirely, as Google and Spotify did.

The other 3 million shares were sold by existing shareholders. This is not reflected in the below cap table.

You can see below the return and rough IRR each of the investors made at the IPO (using the IPO price and date, that is).

Owner	Date	Common Stock	Conv Pfd Stock*	Total Stock	%	Investment	Value @ IPO	Return	Rough IRR
Chase	1/2000	570		570	1.3%		$10,260
Danielson	1/2000	411		411	0.9%		$7,398
Convertible notes	?/2000	101		101	0.2%	$325	$1,811	5.6x	17%
Series A investors	10/2000		695	695	1.5%	$1,036	$12,514	12.1x	27%
Series B investors	12/2002		4,704	4,704	10.4%	$4,704	$84,679	18.0x	39%
Series C investors	11/2003		2,857	2,857	6.3%	$4,000	$51,435	12.9x	38%
Series D investors	1/2005		5,059	5,059	11.2%	$11,736	$91,054	7.8x	39%
Series E investors	11/2006		3,249	3,249	7.2%	$25,015	$58,477	2.3x	21%
Series F (Flexcar)	11/2007		7,154	7,154	15.8%		$128,768
Series G investors	12/2010		1,380	1,380	3.0%	$21,000	$24,836	1.2x	50%
Streetcar acquisition		4,093		4,093	9.0%		$73,670
Exercised opts & rest stock		1,448		1,448	3.2%		$26,059
Option pool & warrants out		6,997		6,997	15.4%
IPO shares	4/2011	6,667		6,667	14.7%	$120,000	$120,000
Total		20,286	25,098	45,383		$187,816	$690,948

If my numbers are correct, Chase had stock valued at about $10 million at the IPO. Danielson had $7 million. These are not numbers to sneeze at. On the other hand, starting a company that becomes worth $700 million and goes public is unusual. The reward for doing so should be large.

Other things to note:

•  Because of their lack of an anti-dilution clause the convertible note investors received less than half the multiple that the Series A investors did, even though they invested earlier and took more risk;
• By IRR, the Series A investors did fine, but worse than the Series B, C, and D investors because they overpaid during the dot-com euphoria;
• The Series B investors, meanwhile, had an 18x multiple, the best of all the investors, because they invested when prices were low;
• The Series B, C, and D investors all had a very similar IRR: this is evidence of efficient pricing;
• The Series E investors had a lower IRR; this may be because the period between 2006 and the IPO in 2013 was difficult;
• The Series G investors had the highest IRR of all, even though they had the lowest multiple! Investing just prior to an IPO is a good business that way.

Soon after the IPO the stock price climbed to $29/share, valuing Zipcar at more than $1.3 billion. But it didn’t last. The price fell over the next few years, slipping down under $8.25/share. On January 2nd, 2013, Avis announced they wold buy Zipcar for about $500 million, or $12.25/share. The acquisition was completed on March 14, 2013. Scott Griffith announced he was leaving the company the next day.

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1. http://fortune.com/2012/12/04/robin-chase-zipcars-founder-finds-a-new-gear/ ↩

2. https://www.crunchbase.com/funding_round/zipcar-series-c–d060b78a ↩

3. https://www.theverge.com/2014/4/1/5553910/driven-how-zipcars-founders-built-and-lost-a-car-sharing-empire ↩

4. https://www.cnbc.com/id/100349819 ↩

5. https://cb.hbsp.harvard.edu/cbmp/product/803096-PDF-ENG ↩

6. http://fortune.com/2012/12/04/robin-chase-zipcars-founder-finds-a-new-gear/ ↩

7. https://mitsloan.mit.edu/LearningEdge/CaseDocs/14-153.Robin%20Chase%20and%20Zipcar.FINAL.pdf ↩

8. I can’t know this for sure, but the conversion ratio from preferred to common in the prospectus is 2 for all classes of preferred shares except the Series A, where it is 0.784. That means that for every 3 shares of Series B, 1.5 shares of Common are issued at the IPO, but for every 3 shares of Series A, 4 shares of Common are issued. I can’t think of any other reason for this than an adjustment to the conversion price as a result of anti-dilution being triggered. ↩

9. The mechanism for this is not for more Series A shares to be issued by the company, but for the conversion price of the shares to change. The conversion price starts at the price actually paid but is changed by the anti-dilution clause. The number of Common shares issued when the preferred shares are converted is determined by multiplying the number of preferred shares by the ratio of the conversion price divided by the original price. If you do the math, this works out to be the number of shares you would own if you divided your original investment amount by the conversion price instead of the original price per share. ↩

10. When doing the math, there’s something else strange going on. To get to the actual conversion price as mentioned in the Prospectus, the number of shares outstanding before the Series B round must be about 997 thousand. This doesn’t seem to count the option pool (which is usually counted), the Series A stock, or the Common issued to the Convertible Note investors. In fact, it only seems to count the founders’ stock. If this is how it is written, it would be the first time I’ve ever heard it done that way. I assume I am just missing something. ↩

11. It doesn’t always work out this way even if the letter of the contracts says it should. Sometimes acquirors insist that Common holders, especially if they are founders, receive part of the purchase price. Sometimes investors give up part of their preference in deference to the founders. Every contract is both the end and the beginning of a negotiation. ↩

12. https://www.sec.gov/Archives/edgar/data/1564408/000119312517068848/d270216d424b4.htm ↩